After a weekend spent picking over the bones of Lehman’s demise, David Dawkins speaks to the industry about what went wrong, and what’s to come
‘A programme on Radio 4 yesterday really got my goat,’ says Chris Wyllie, Connor Broadley’s chief investment officer. ‘You hear this lazy reporting that starts – ‘‘10 years on from the financial crisis that began with the demise of Lehman Brothers’’ – it didn’t begin’ he stresses, ‘it ended, or culminated in Lehman going down. But everyone seems to have forgotten.’
It’s a frustrating time for capital market insiders. The cycle of post-crisis recovery is nearing its end – there’s an audible hum of concern – but the world’s finance media is currently pointed in the other direction.
It’s not that the so-called remorseless bankers – the villains of the piece now bound by post-crisis regulatory change – are merely grumbling at being reminded of their role in the global collapse. There’s a feeling now that clumsy readings of the past leave us exposed to increased risk in the future.
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Wyllie, now at Connor Broadley, a veteran investor having worked for Schroders and JP Morgan, before taking the Guinness family portfolio at Iveagh, tells Spear’s that when you start the story with Lehman and bypass ‘belly up’ hedge funds and Northern Rock – ‘people are drawn to the wrong conclusions’.
He adds: ‘The reason why Lehman eventually toppled – it finally got to the point when the risk was reverberating around the system’, the important word being not ‘risk’ but system. In short, how much can be gained by focusing on Lehman and looking for like-for-like institutions and scenarios? The real question for wealth professionals in 2018 should be: how has the so-called ‘system’ changed, where is the risk, and when it lands, and can we cope?
He tells Spear’s: ‘When I read these reports that ask – “Just how much has really changed in the ten years since Lehman?” Well, actually quite a lot’. Wyllie argues that we’ve had ring-fencing of assets, the Volcker Rule, and a ‘transformation’ in terms of the capital base in the banks. He says that if lessons are really going to be learnt, ‘the lazy narrative that just focuses on Lehman and the cheap shot that ‘nothing has really changed’ needs to end’.
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As the rules and regulations have tightened, global asset allocation looks different today compared to the landscape in 2008. Linklaters reported last week that the total assets held by Asian banks have grown 600 per cent since the financial crisis while European bank assets have fallen 52 per cent. Commenting on the report, Michael Kent, global head of finance and projects at Linklaters, said that since the crisis, banks across the world have seen an unprecedented wave of regulation hit them and that ‘some markets have fared better than others’.
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So with certain markets ‘faring better’ than others, have European banks merely adapted to the last banking crisis by regulating themselves into a beta male role alongside the US and Asia in the global markets?
On face value, the regulatory change that forced banks in Europe to hold more assets as a capital buffer, rising from 3.4 per cent in 2008 to 5.5 per cent last year, looks like a conservative play.
In search of better terms, assets have moved and for some, this is another chapter in the rise of Asia and the death of Europe as a global banking powerhouse. It also looks like the move from a light-touch model to a far more rigorous system has strangled European banking.
But the idea is firmly rejected by Wyllie.
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‘The idea that “growth is good, contraction or shrinking is bad” – I wouldn’t agree with that. You’ve now got banks in Europe that had core equity tier one ratios of 3 to 4 per cent in 2007 and have 13 to 14 per cent now.’ He adds that the bigger capital buffers are a ‘good thing’ and a ‘very good reason to think that wherever we are in this cycle, going into the next one, it’s much less likely to be a full-blown banking crisis like last time.’
Support comes from Sidharth Shankar, CEO of Tails Trading, who tells Spear’s that to understand this phenomenon, the first thing to keep in mind is the very essence of assets and that a rise in assets does not mean a rise in profits.
Shankar says that the ‘rise in Asian banks’ total assets is mostly due to the overvalued real estate and government loans’. Adding that this is especially true in China, the actual return on assets was never above 1.45 per cent in the whole of the last decade. It would not mean much in a positive way for the rise. He says, ‘on the contrary, this six-fold increase is a sign of danger for the actual appraisal of assets in Asia. Would these assets’ value stand? What’s more, all these assets are quite impossible to be liquidated due to the US-China trade war.’
And so to the next crisis? The year 2020 – a Spear’s exclusive or a slightly brittle, consensus opinion?
Wyllie tells Spear’s, ‘we’re seeing all the things that happen at the end of the cycle. We’re seeing the dollar strengthen, we’re seeing the oil price pick up, we’re seeing emerging crisis start – we’re getting the tremors.’
But the so-called ‘big daddy’ for Wyllie are signs of a ‘flattening’ bond yield curve that ‘could invert in the next three to four months’.
‘Everyone’s on tenterhooks watching that,’ he says. ‘we all talk, but that’s the key indicator of recession.’
But returning to the pointlessness of using Lehman and the ‘lessons learnt’ narrative to predict the next financial downturn, Wyllie suggests two broad brushstroke approaches.
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Firstly, Wyllie says that ‘if a rate rising cycle is considered the starting gun – recessions follow the first rate rise by 3.5 years,’ therefore if you apply 3.5 years to when the Federal Reserve started raising rates – December 2016 – ‘you’re going to land in mid-2020.’
Another theory or way of posing the question Wyllie says is yield curve-inversion typically ‘preempting recessions by about 16 months on average’. Although we haven’t had the yield curve-inversion yet, if it were to happen soon adding another 16 months would take us to a date in 2020.
However, for Wyllie, there’s a problem with this arbitrary date of 2020.
‘It’s all a bit consensus’, he warns. ‘Your average personal investor knows we’re late in the cycle, she’s saying – “I know I need to be worried about that; I can’t really see exactly what’s going to cause it right now; it won’t be next year; let’s call it the year after that”. Conclusion: “it bothers me but I don’t really need to worry about it. I don’t need to re-position my portfolio right now, I’ll do it before everyone else just in the nick of time.”
‘That’s the risk and it does worry me a bit that there could be a bit of complacency around this.’
David Dawkins is a senior researcher at Spear’s
Photo credit: Jorge Royan @ Wikimedia Commons
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